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Privatization or else.

In a massive privatization program, the CIS has thrown open its doors to foreign investment. A former deputy prime minister of the U.S.S.R., who now heads the Russian equivalent of the Treuhand, lays out arguments in favor of Western involvement--and talks about some of the risks.

Call them capitalists without capital. Convinced of the need to convert to a free-market economy, the CIS has opened its arms to foreign investment and embarked on an ambitious, radical privatization program. With few exceptions, however, the country's businesses remain starved for the hard currency needed to upgrade aging, decrepit equipment and to retrain workers, while the program itself limps along, hamstrung by corruption and political infighting. Stateside and elsewhere in the West, companies generally appear wary of the turmoil: Most have proved unwilling to rummage for bargains in the CIS.

Conceived as part of a broader package of economic reforms and codified by Russian President Boris Yeltsin last January, the plan aims to privatize by 1994 all trade, consumer services, and small industries; a significant portion of housing; and as much as 30 percent of large and medium-sized enterprises. In a twist unique to the privatization efforts of former Communist countries, the government has issued citizens and company managers vouchers to buy shares of enterprises.

In recent months, however, opposition to privatization has been mounting. Among its enemies: the "industrial nomenklatura," bureaucrats and managers of state-owned industries, the vast majority of whom favor some privatization, but only at a "go-slow" pace cushioned by plenty of government subsidies. Many industrial chieftains back the Civic Union, a political bloc organized by Arkady I. Volsky, head of the powerful Union of Industrialists and Entrepreneurs, and Aleksandr V. Rutskoi, Yeltsin's vice president. The group wants to hit the brakes on the sell-off of state assets, slated to begin this year.

Unconvinced the government has the resolve or capacity to get the job done, private investors and organizations have moved to fill the breach. Enter the International Foundation for Privatization and Foreign Investment, headed by Vladimir Scherbakov, a former first deputy prime minister in the government of Mikhail Gorbachev.

In a recent article, ("Privatization In The CIS," CE: November/December 1992), Scherbakov characterized FPI as roughly the equivalent of a Western investment bank. The organization, he said, acts as an intermediary between outsiders and operations formerly held by the Soviet government. FPI takes a stake in some of the deals it arranges and, in some cases, it receives a percentage of any transaction that is made.

"Interprivatizatsia," as it is known in Russian, was chartered in February 1992, and has a market capitalization of 350 million rubles and $85 million. It has a working relationship with foreign law firms, insurance companies, industrial concerns, and banks, including Rothschild Bank and Deutsche Bank.

Ironically--perhaps in a sign of the confusion and shifting alliances wracking the former U.S.S.R.--the Union of Industrialists and Entrepreneurs is a co-founder of FPI, while Arkady Volsky is a member of its Supervisory Board.

Quick off the mark, FPI has tackled a number of projects, setting up sea terminals jointly with Kensington Group to ship condensed gas, constructing a facility in Siberia to produce one million tons of methanol per year, and holding an international tender offer in conjunction with New York-based Bankers Trust to develop the Udokan copper ore deposit, the world's largest. Of the first 100 privatizations in the CIS, FPI has completed 70--an astounding figure for an extra-governmental organization in a confederation still based largely on command and control.

Recently, Scherbakov addressed a group of business leaders and their wives assembled in New York by CE. He outlined the prospects for privatization in the CIS and sought to assure his audience that the champions of reform are pushing ahead. But subsequent events have raised questions about how quickly reform can be achieved. Bowing to conservative pressure last month, Yeltsin sacked Acting Prime Minister Yegor Gaidar, a radical, free-market economist, and replaced him with Viktor Chernomyrdin, a former Communist Party apparatchik. Chernomyrdin supports privatization and reform but likely will grant increased credits to industry, a move that may kick inflation of 25 percent a month into hyperdrive. Amid the chaos, Barron's articulated the unspeakable: "Russia is on the verge of collapse."


Vladimir Scherbakov (International Foundation for Privatization and Foreign Investment): The purpose of our meeting is to find ways for Russia and America to successfully walk the road to mutual cooperation.

Before I begin, however, I must point out a difference between us. It seems that while there is a Communist Party in the U.S., we no longer have a Communist Party in Russia. |Laughter.~ Also, democracy is developing at a rapid pace in our country. Too rapid, perhaps. At gatherings such as this you display the flag of Chief Executive magazine. My associates and I don't know what kind of flags we should put at our tables. |More laughter.~

In the CIS, some basic laws of a market economy have been put into effect. The independent republics have assumed the former Soviet debt and moved to ensure the convertibility of the ruble. They have attempted to guarantee the security of foreign investments. They have established so-called Free Enterprise Zones.

That is not to say there are no problems in the CIS. Let me touch on several of them. The first involves political and social instability. I can say with confidence that the threat of a coup in Russia--with a subsequent return to a Communist regime--is non-existent. There is no danger that any foreign-owned property or investment will be expropriated. Given the somewhat volatile economic situation, the risk of strikes, national conflicts, and mass unrest remains--particularly in some of the outlying republics. But in most cases, we at FPI believe this situation to be under control.

In addition, some technical problems remain unsolved. There is an acute shortage of legal and commercial information--many enterprises in the CIS are not yet fully acquainted with the finer points of Western profit-and-loss accounting, for example. With few exceptions, the infrastructure of most cities and republics is still in the development stage. Our managers are relatively inexperienced.

Theoretically speaking, the business circles of the West recognize that the building of a stable, mature market economy in the CIS will require substantial time and resources. In practical terms, however, the level of direct and indirect Western investment in our economy remains relatively small.

American investors lag behind European investors--particularly behind those in Germany. Few large U.S. companies have invested substantially in the CIS: American investments in 1991 failed to reach $500 million--that's less than U.S. investments in Hungary. But there are more shocking statistics. In our country, there are 4,000 joint ventures, and of them, only 13 percent are with American partners. Overall, only 1.3 percent of all joint ventures actually made investments.

What is the role of FPI? Many of you have tried to work on investment projects in the former Soviet Union, and you know how difficult it is. The requirements and capabilities of potential CIS partners differ from republic to republic, and even from manufacturing facility to manufacturing facility. The legal and financial obstacles to putting together a deal can be enormous. Then there's red tape. You think your bureaucracy is big? Ours is larger. The problem in Russia is that every local official, every bureaucrat, may have the power to make or break a deal. The situation is quickly changing. But for now, this is the reality.

FPI is equipped to link up Western investors with foreign partners. To date, we have completed 70 percent of all privatizations in the CIS, and this year, we plan to privatize 300 more government-owned projects.

Our largest project--with telecommunications and electrical equipment manufacturer Siemens AG of Germany--aims to create a new system of telecommunications based on platforms in space. We also have completed the privatization of the Ust-Kamenogorsk lead and zinc mining works, responsible for 75 percent of the lead and zinc output of the former U.S.S.R. As our expertise expands, we also aim to implement an investment fund and to become more involved in project finance.

Of course there are remaining problems in Russia and the other republics. But we believe the potential gains outweigh the possible risks. Many projects and investments are up for sale at a fraction of their true value. But this situation will not last forever.


Richard M. Clarke (Akzo America): Could you comment on the policies your country may have regarding the energy or chemical industries?

Scherbakov: Last year, the government passed legislation offering tax abatement and other incentives for joint ventures in the petrochemical sector. Moreover, unlike some industrial sectors, this is an area in which there is no shortage of high-quality partners. Over the years, our managers in this area have developed quite a bit of expertise. We are working on a number of promising projects in the petrochemical arena.

William R. Toller (Witco): We signed a protocol for a joint venture in the Soviet Union about three years ago to construct a modest-sized petrochemical plant. In the ensuing three years, things have ground virtually to a halt. Can we expect the pace to pick up, or will it be some time before we see some activity in this sector?

Scherbakov: Everything depends on your partners. If they take a proactive approach to the deal, you may begin to see some movement.

I'm not sure about the specifics of your case, but there may be another problem. Legally, agreements signed three years ago are still valid. But in point of fact, many entrepreneurs in the CIS do not feel bound by agreements forged that long ago.

K. Grahame Walker (The Dexter Corp.): We are thinking about making some investments in Russia, which is, of course, home to many talented scientists. We would like to hire some of these people and bring them to the U.S. for training. My question is: Where would we best find such candidates?

Scherbakov: There are a few organizations that deal with recruiting young people. Some deal specifically with the pure sciences. When you are ready to begin a search, our office in San Francisco can provide you with the details.

John S. Chalsty (Donaldson, Lufkin & Jenrette): What is your take on the convertibility of the ruble? More specifically, at least in the near term, how likely is it that those who invest will be able to get their profits out?

Scherbakov: President Yeltsin has moved to introduce a single-ruble exchange rate. In addition, hard currency auctions have been introduced, making our "softer" currency somewhat more convertible.

This may be changing the subject, but let me suggest the tax consequences are much more favorable if the profits from a venture are reinvested. In most cases, investors should be prepared to take a longer-term approach to the market.

Donald G. Sullivan (J. Walter Thompson Worldwide): Let me change the pace a little bit. What efforts are being made to straighten out the agricultural situation?

Scherbakov: The main problem in agriculture is the absence of adequate infrastructure and equipment. But we see some promise in the sector. Holland, Israel, Spain, and Germany are all making investments in this area.

Robert R. Corliss (Herman's Sporting Goods): Can you comment on the availability of consumer products and the distribution network that is being set up to handle them?

Scherbakov: This touches on one of the basic flaws of our former command-and-control economy. In essence, our economy was not only militarized, it was based heavily on raw materials. Trade in the latter was one of our only sources of valuable hard currency. Prior to the coup, only 15 percent of our gross industrial output was earmarked for consumers.

Now, the government is saying to former military factories, "Make pots and pans." But it isn't quite that simple. Conversion costs money: Recently, in the case of one factory, the figure amounted to $30 million.

This is a long-winded way of saying the demand for quality consumer goods still outstrips supply by a substantial margin. It will be some time before things approach what you might call "normal."

There is a joke making the rounds in my country. A manufacturer of machine guns is asked to convert his factory to make sewing machines. He takes great pains with the conversion. He recruits a new work force. He draws up detailed plans, and begins production. And when the final product comes out, it is still a machine gun. |Laughter.~

The process is very complicated, and we still lack necessary technical and management expertise.
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Title Annotation:privatization in the Commonwealth of Independent States
Publication:Chief Executive (U.S.)
Date:Jan 1, 1993
Previous Article:Economic advice for President Clinton.
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